NC State Economist
C O L L E G E O F A G R I C U L T U R E & L I F E S C I E N C E S
North Carolina Cooperative Extension Service
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Agricultural and Resource Economics • January/February 2009
2009 Economic Outlook: Containing the Damage
The National Economy: The Recession Arrives
M. L. Walden, William Neal Reynolds Distinguished Professor and Extension Economist
Review of 2008
On December 1, 2008, it became official – the
U.S. economy was in a recession and had been in
a recession for a year. The pronouncement was
made by the National Bureau of Economic Re-search
(NBER), a private research organization
that is charged with dating the ups and downs in
the economy. To many the announcement was not
startling, because certainly what had been happen-ing
in the economy during 2008 "looked and felt"
like a recession, if not worse.
The main indicators of a recession are found in
the first three rows of Table 1. Real (inflation-adjusted)
gross domestic product (GDP) is the
broadest measure of economic activity and tracks
the collective production of all firms. Although final
2008 numbers are not yet in, growth in real GDP is
expected to be at best only slightly positive (as
shown here) or actually negative for the year, and
well below 2007's value. Employment growth will
be unambiguously negative, which is also reflected
in the jump in the unemployment rate. The conclu-sion:
the economy experienced a broad-based
decline in 2008 which, in the judgment of the
NBER, qualified as a recession.
Other measures in Table 1 reflect 2008's
recessionary conditions. Production from the
nation's factories (industrial production) dropped;
consumer income (real disposable personal income
per capita) and real consumer spending also
posted declines; and consumers significantly
reduced their debt loads (household debt service
ratio) – something that's rarely been seen in recent
years – in response to the deteriorating economic
conditions and uncertainty about the future.
As is now well known, the driving force behind
the recession has been the contraction in the
national residential housing market. Low interest
rates, easily available loans, and the chance to earn
tax-free capital gains made residential housing the
premier investment in the early 2000s. Home
construction boomed, homeownership rates
soared, and perhaps most importantly, price
appreciation for homes reached unprecedented
double-digit annual rates. Fearing a speculative
bubble, the Federal Reserve began increasing
interest rates in 2004 and continued this policy
through 2007. The goal was to gradually "deflate"
the housing bubble and bring appreciation rates
back to normal levels between 2% and 4% per
year.
Unfortunately, the policy didn't work. High-risk
buyers with adjustable rate mortgages began
defaulting, and the retreat from the housing market
turned into a rout. By 2008, average housing
prices were actually falling – in some markets by
double-digit rates. Lenders and investors who had
bet on continuing rising home prices now found
that those investments had turned toxic, and the
ensuing plunge in the housing market began to pull
down the entire financial system.
This situation set the stage for the government
"bailout" of the financial system. Beginning in the
spring of 2008, the U.S. Treasury Department and
the Federal Reserve initiated a series of actions to
stabilize banks and other financial institutions.
These included low cost loans, purchase of non-performing
loans, and outright purchase of equity
in financial firms. The Federal Reserve also
dramatically lowered its key short-term interest
2 NC State Economist
2007 2008 2009 (forecast)
Real U.S. Gross Domestic Product (% chg.) +2.3% +0.7% -2.5%
Payroll Employment (% chg.) +0.8% -1.5% -1.3%
Unemployment Rate (end of year) 5.0% 6.8% 8.0%
Industrial Production (% chg.) +2.0% -1.2% -3.5%
Real Disposable Personal Income (% chg.) +0.9% -0.8% -1.10%
Household Debt Service ( chg in % pts) -0.20 -3.50 -3.00
Real Consumer Spending (% chg.) +2.2% -0.2% -1.5%
Housing Prices (% chg) +0.8% -4.0% -4.0%
Housing Excess Supply (no.of months) 9.8 11.2 10.3
Consumer Price Index (% chg.) +3.2% +3.5% +1.5%
Core Consumer Price Index (% chg.) +2.3% +2.2% +1.8%
3-Month Treasury Bill Rate (chg in % pts) -1.90 -3.10 no chg
10-Year Treasury Bill Rate (chg in % pts) -0.50 -0.60 +0.10
30-year Fixed Rate (chg in % pts) -0.12 -0.24 no chg
1-yearAdjustable Rate Mortgage (chg in % pts) no chg -0.25 no chg
S&P 500 Stock Index (% chg.) +2.0% -38.0% +5.0%
Deficit to GDP Ratio (% chg.) -1.7% -3.5% -6.0%
Table 1. Key U.S. Economic Measures
Sources: U.S. Dept. of Commerce, Federal Reserve System, Office of Federal Housing Enterprise Oversight, U.S. Census
Bureau, author’s forecasts. Values for 2008 are annualized rates based on the latest available data.
rates and at the end of 2008 began to substantially
increase the nation's supply of money and credit.
These actions were based on the belief that the
financial system is crucial to the economic system –
that without a functioning financial system, com-merce
and production would stall and
unemployment would rise to unacceptable levels.
However, the size of the housing market collapse
and the resultant losses in financial firms were large
enough that a recession became inevitable. There-fore,
the federal government's actions in 2008 were
intended to contain the recession, not prevent it.
The imbalances in the residential housing market
can be seen by two indicators in Table 1. "Housing
prices" is the national average rate of appreciation
for homes based on an analysis of repeat sales by
the federal government. The measure posted a
modest gain in 2007, but slid by 4% in 2008.
Other indicators of changes in home prices, such as
the so-called Case-Shiller index, show a reduction
in home prices in both 2007 and 2008 and by
larger amounts. The second indicator "housing
excess supply" is the months of housing inventory
available for sale. A normal level is six months.
The levels for both 2007 and 2008 were well
above this level.
Inflation and interest rates both took wild rides in
2008. Led by surging energy prices, the annualized
inflation rate reached over 6% during some months
early in the year. By year's end, however, collapsing
energy prices pulled average price changes down to
deflationary levels. Thus, the "total inflation rate" for
the entire year is somewhat deceptive because it
combines two entirely different performances during
the year. Perhaps a more accurate view of price
changes is provided by the "core inflation rate", which
excludes changes in volatile energy and food prices.
This measure showed a modest 2.2% gain over the
year, similar to 2007's performance.
Interest rates on the benchmark Treasury securities
edged lower in 2008. The reduction was much greater
for short-term rates (T-bill) than for long-term rates
(T-note), suggesting a market view that the reduction
in loan demand, and the drop in inflation is temporary.
Interestingly, interest rates on many private loans, such
as mortgages, did not follow this path. Those rates
rose in early 2008 as investor concerns about risks in
the housing market mounted. But once the Federal
Reserve announced the purchase of a large quantity of
mortgages held by the secondary lenders Fannie Mae
and Freddie Mac at the end of 2008, mortgage
January/February 2009 3
The North Carolina Economy: In Recession, but Improvement from the Past
The recession also came to North Carolina in
2008. Although payroll employment increased
slightly for the year, the unemployment rate rose
over two percentage points from 2007 (Table 2).
Real (inflation-adjusted) retail sales, real wages per
employee, and existing home sales also declined by
significant rates. As a result, state revenue growth
interest rates tumbled and will end the year slightly
lower.
The final two indicators in Table 1 illustrate the
problems evident in both the private and public sectors
in 2008. Clearly the stock market had a horrendous
year in 2008 – indeed, one of the worst in the post-
World War II period. The market decline began in the
fall of 2007, thereby preceding the beginning of the
official recession, and continued throughout 2008 as
the recession deepened. The rise in the federal (na-tional)
debt to GDP ratio in 2008 reflected the increase
in borrowing by the federal government to fund the
additional spending used to combat the recession.
Issues and 2009 Forecasts
The forecasts for 2009 in Table 1 are grim. The
leading broad-based measures of economic growth –
real U.S. GDP, payroll employment, and industrial
production – all show expected declines over the year
and the projected unemployment rate indicates a major
jump in joblessness. Real disposable personal income
per capita and real consumer spending also will retreat.
On the positive side, households will continue to
reduce their debt service ratios, inflation should be
tame, and interest rates won't rise. The housing market
should also hit bottom and begin the road to improve-ment,
although the path will be long and uneven and
recovery will certainly not be full. The brunt of the
drop in the economy will occur in the first half of the
year, with more moderate losses in the second half, or
– if we're lucky – some modest growth.
Clearly the key issue for policymakers, including
those at the Federal Reserve and in the new Obama
administration, will be to contain the immediate eco-nomic
damage from the recession. To this end, a new
fiscal "stimulus" plan focused on infrastructure spending
(roads, bridges, public buildings) will likely be
passed early in 2009. An income tax cut for low
and moderate income households could also be
forthcoming. The total public cost of the package
could be $500 to $750 billion.
At the same time, the Federal Reserve, in
coordination with the Treasury Department, will
continue to support the financial system through a
combination of loan guarantees, equity purchases,
and credit creation. The continued functioning of
the financial system is considered essential to the
performance of the wider economy. Without an
operating financial system, the "lifeblood" of the
economy– money and credit – would stop
flowing.
It is important to realize these government
actions are not without cost. The new stimulus
package and potential tax cuts will be financed
through borrowing, as are the funds used by the
Treasury Department to invest in financial firms.
This additional public borrowing will add to future
interest payments on the national debt, which will
have to be financed either by reductions in other
federal spending or future tax increases. The
enhanced money and credit creation by the Fed-eral
Reserve can lead to higher inflation rates in
later years.
However, the public policy tradeoff is this: if
the additional federal government stimulus is not
taken, the very real risk is that the recession will be
deeper, unemployment will be higher, and income
losses will be greater. So the calculation is to
reduce economic losses now in exchange for
higher public and private costs later.
slowed dramatically in 2008 compared to 2007.
This development has put pressure on public
budgets all over the state.
However, the recession to date in North
Carolina has been milder than in past downturns.
Unlike the nation, total payroll jobs were not lost in
2008, and the rate of manufacturing job losses has
NC State Economist
North Carolina Cooperative Extension Service
North Carolina State University
Agricultural and Resource Economics
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2007 2008 2009 (forecast)
Payroll Employment (% chg. ) +2.6% +0.10% -1.1%
Manufacturing Employment (% chg. ) -2.7% -4.7% -3.5%
Unemployment Rate (end of year) 4.7% 7.2% 8.6%
Real Wages Per Employee (% chg. ) +1.1% -3.1% -2.5%
Real Retail Sales (% chg. ) +4.7% -8.2% -2.5%
General Fund Revenue (% chg) +11.1% +2.2% -3.0%
Housing Prices (% chg) +5.1% +2.0% no chg
Existing Homes Sales (% chg) -11.1% -26.0% +7.5%
Table 2. Key North Carolina Economic Measures
Sources: U.S. Dept. of Commerce, N.C. Dept. of Revenue, Federal Reserve System, N.C. Controllers’ Office, Fiscal Research
Division of the N.C. General Assembly, Office of Federal Housing Enterprise Oversite, North Carolina Association of
Realtors,author’s forecasts. Values for 2008 are annualized rates based on latest available data.
been one-half less than in the 2001 recession. The
recent transformation of North Carolina from tradi-tional
manufacturing (tobacco, textiles, and furniture)
to a technology and service driven economy – which
accelerated this decade – is the reason for these
relatively better results.
One positive trend in North Carolina has been the
continued rise in housing prices. Still, there are some
areas – mainly on the coast – where housing prices
have fallen. Also, despite the better condition of
housing prices in North Carolina, the state still has not
escaped the increased foreclosures plaguing other
regions of the country.
Looking ahead to 2009, North Carolina’s
economy will essentially follow national movements.
For the year, this will mean job losses, higher
unemployment, and weak retail sales and wage
growth. Home sales will rise off their bottom, but
the housing market will still remain weak. With
general revenue growth negative, legislators will face
their biggest challenge in two decades in balancing
the state budget.